Companies’ financial statements are packed with numbers and figures that may seem confusing at first glance. While taking a templated approach to analyzing financial statements is an easy way to help procurement staff evaluate such dense documents a one-size-fits-all approach could cause procurement staff to misinterpret outliers.
By taking stock of the most influential line items on balance sheets and other financial statements, procurement staff can begin to recognize patterns and make their own conclusions about suppliers’ financial health.
Not sure where to start? Read on for ProcurementIQ’s rundown on the top line items to consider and what they mean.
A company’s income statement is often the subject of press releases and news articles. The point of a press release is often to attract investors, which is why revenue and profit are top of mind when drafting the announcement. A company’s earnings, or profit, have long been used as a quick measure of success and determinant of share prices.
The income statement shows how a company’s revenue (top line) nets down to a profit (bottom line) over a period of time. But not all profit figures tell the same story, so it’s important to make distinctions between gross profit, operating income and income (loss) before income taxes, all of which can be used when evaluating profit.
Gross profit is total revenue minus cost of revenue, or cost of goods sold. But what does gross profit mean for a business? Gross profit is basically the money available to pay the company’s expenses.
As the old saying goes, you have to spend money to make money, which brings us to cost of revenue. Also called cost of sales, cost of services or cost of goods sold, cost of revenue represents the direct costs of producing the goods or services sold by a company.
Meanwhile, operating expenses cut into gross profit, too. Operating expenses are also known as sales, general and administrative expenses (SG&A). These expenses are accounted for in operating income. A company’s operating income is its profit after deducting operating expenses.
This leads us to Income (Loss) Before Income Taxes, which is operating income minus income taxes. Subtracting income taxes from operating income helps analysts and procurement professionals better compare profitability across different geographies. Because income taxes are not universal, looking at income before income taxes can be helpful when assessing companies that operate in different states or countries.
A company’s balance sheet provides a snapshot of a company’s assets, liabilities and shareholders’ equity at the end of the reporting period.
Analyzing variances to determine how much each item changes from one period to the next (month to month, quarter to quarter or year to year) can help procurement departments identify risks and get a better idea of how a company manages their assets and liabilities.
Total current assets represent all the assets of a company that are expected to be sold or used during standard business operations throughout the year. Included in current assets are:
- cash equivalents
- accounts receivable
- stock inventory
- marketable securities
- pre-paid liabilities
- other liquid assets
Current assets tell procurement departments what resources are available to fund day-to-day business operations and to pay for the ongoing operating expenses.
In addition to current assets, the total assets calculation includes non-current assets or long-term assets. While current assets are those that can be liquidated within a year, long-term assets are liquidated in more than a year. Examples of long-term assets include fixed assets such as a company's property, plant and equipment, but can also include other assets such as long-term investments or patents.
PRO TIP: Noteworthy declines in long-term assets may signal financial distress, indicating that a company lacks the cash to cover operating expenses and must liquidate long-term assets to stay afloat. Meanwhile, a noteworthy increase in long-term assets tells a different story. Though investments into long-term assets may drain revenue, the company’s investments can pay off in the long run.
Current Liabilities are a company's short-term financial obligations that are due within the year. Examples of current liabilities include:
- accounts payable
- short-term debt
- notes payable
- income taxes owed
Unpaid supplier invoices, referred to as accounts payable, are often one of the largest liability accounts on a company's balance sheet.
Total liabilities are the combined debts and obligations a company owes to outside parties. These liabilities include:
- monthly lease payments
- utility bills
- bonds issued to investors
- corporate credit card debt
Unearned revenue, which represents any payment received for a service or product that has yet to be provided, is also recorded as a liability.
PRO TIP: When evaluating liabilities, procurement departments weigh assets against liabilities to determine whether there is enough cash on hand to take care of bills. Companies that lack the assets necessary to offset liabilities are at higher risk of insolvency.
Liabilities and assets become even more entwined as you reach the equity portion at the bottom of a company’s balance sheet. Equity represents the value that would be returned to a company’s shareholders if the company liquidated all assets and paid off all debts. Equity is calculated by subtracting liabilities from assets.
When looking at equity, procurement departments should consider the total equity attributable to the parent, which excludes temporary equity. As the name implies, total equity attributable to the parent represents the amount of stockholders' equity that is allocable to the ownership interest, excluding any subsidiary equity (noncontrolling interest, minority interest).
PRO TIP: Why exclude subsidiary equity? Ownership of a subsidiary is typically denoted as an asset on the parent company's balance sheet. To eliminate overlaps, procurement departments should consider only the equity that is allocable to the parent.
A company’s cash flow statement covers all cash inflows the company receives from ongoing operations and external investments.
The cash flow statement is often considered the most intuitive of the three main financial statements. That’s because it integrates information from the balance sheet and income statement to help interested parties track the success of a company’s transactions.
PRO TIP: Analyzing a company’s cash flow statement is one way of determining its life cycle stage and liquidity position.
Net cash from operating activities represents the amount of cash a company generates or consumes through its operating activities during a specific period of time. To arrive at this line item, net income is adjusted through additions and subtractions. More specifically, changes in the account balances of current assets and current liabilities, as well as non-cash accounts, are added or subtracted.
While growing companies may have a negative cash flow from operating activities, mature firms often have a positive cash flow here.
PRO TIP: Generally speaking, companies that consistently generate most of their cash from operating activities are healthier than those that do not.
The next portion of a company’s cash flow statement shows the net cash from investing activities. This line item represents long-term uses of cash. For example, if a company buys or sells a fixed asset, they are engaging in an investment activity. Similarly, the sale of a business unit or division is considered an investing activity.
While companies in all stages may have positive cash flows from investing activities, growing companies almost always have a positive number for this line item because they make significant investments to get operations up and running. Looking at a growing company’s investment activity can give procurement departments an idea of how much cash will be left to make future investments.
Meanwhile, mature companies may have easier access to financing, meaning their investments hold less weight. A mature company with growing investments may still generate positive cash flows from operating activities and generate plenty of cash to keep their operations running smoothly.
Next up is net cash from financing activities, which shows the net cash flows used to fund a company’s operations. This line items gives procurement departments an idea of how well a company’s capital structure is managed. Examples of financing activities include dividend payments, stock repurchases or bond offerings.
When looking at net cash from financing activities, a positive number means the company has more money coming in than flowing out. Meanwhile, a negative number means the company is paying off debts, or is making dividend payments and/or stock buybacks. Companies in the decline stage of the life cycle often display negative cash flows from financing activities as they use money from their businesses to pay back investors.
The change in cash and cash equivalents, sometimes called net change in cash, sums the three line items above to give procurement departments an idea of a company’s ability to fund its operations without securing loans or other outside funds. This line item also accounts for the exchange rate, when applicable.
PRO TIP: While this line item provides a quick look at a company’s liquidity, analyzing each of the three parts can give procurement departments more insight into how a company manages its resources.
Finding Financial Statements
Company financial statements can be found in a variety of places, including the SEC’s database. The SEC publishes companies’ 10-k filings, which include a wealth of information on a company’s performance. Though financial statements are a key part of a 10-k form, they often get buried within pages of corporate information that may not be relevant to procurement. That’s because 10-k forms are more geared toward shareholders.
But what about procurement departments?
Fortunately, financial statements also have a place in market research reports and vendor assessments. To give procurement teams the financial data they need in a digestible format, ProcurementIQ will soon launch a collection of interactive company reports called SupplierIQ. By providing comprehensive financial statements alongside each company’s operational information, competitor matrix, SWOT analysis and other key insights, SupplierIQ helps you analyze current or potential suppliers without the headache.
Ready to save time on supplier research? Get in touch with the SupplierIQ team for more info, updates and sneak peeks on SupplierIQ.
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